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Of Red and Blue Pencils: Three Ways In Which States Can Respond to Defective Noncompete Clauses
Even if you’re only an occasional reader of Suits by Suits, you know that we’re committed to engaging in a practical discussion of the varying ways in which an employee’s covenant not to compete might be legal in one jurisdiction but unenforceable in another. It’s our view that both employers and employees need to know about these potential landmines where the employer operates in multiple U.S. states.
But knowing what the substantive law in each state is regarding noncompetes is only half of the battle. Affected parties need to know not only whether a court will determine that a particular noncompete clause is unenforceable as written, but also what that court will do after it makes such a determination. And that’s what this post is all about.
Broadly speaking, a court can do one of three things with a defective covenant not to compete:
(1) The court can throw out the entire covenant not to compete. This is sometimes called the “red pencil” doctrine.
(2) The court can attempt to rescue a portion of the contractual provision by striking out the portion of the clause that renders it unenforceable. This is often called the “divisibility” or “blue pencil” doctrine.
(3) Alternatively, the court can attempt to equitably reform the contractual provision, where the court can actually re-write the contract to be consistent with the parties’ original intent as modified by the extent of the law.
You might be asking yourself what the difference is between (2) and (3). Consider, for example, a covenant not to compete that says “Jane Doe agrees not to work for any business that competes with Industrial Co. located within a 20-mile radius of Industrial Co.’s headquarters for a term of five years after termination of her employment.” Under a traditional LBI analysis, such a clause would almost certainly be unenforceable; even though the restraint is arguably narrow in scope (20 miles), it is for a very long time (five years).
The next question becomes: how would courts deal with this overbroad clause?
The easiest case is, of course, the red-pencil states; in those jurisdictions, the fact that the clause is invalid is all the inquiry the court need to do. If the employer drafts a bad contract, he or she is simply out of luck. But this bright-line approach is seldom employed in practice; our research shows that there are only three states that are unambiguously “red pencil” jurisdictions: Arkansas, Nebraska, and Virginia. (We've previously discussed noncompetes in Virginia at length, here.)
On the other end of the spectrum are courts that follow the “equitable reformation” doctrine; in those jurisdictions, the court might strike out “five years” and replace it with a more reasonable term of, say, “six months.” Such a court might reason that Jane Doe would have signed a six-month noncompete (since she signed one for five years!), and that she should therefore not get a windfall of a complete release from her obligations to her employer because the contract as drafted was overbroad. The court then “reforms” the contract into something that is enforceable under that state’s law. This is the law in roughly 30 states.
In the middle, then, are the “blue-pencil” jurisdictions, which refuse to actually rewrite the offending contractual provision, but will strike out an offending clause if doing so renders the remaining language enforceable under that state’s law.
In the Jane Doe example above, a “blue-pencil” jurisdiction would come to the same result as a “red-pencil” jurisdiction; there is no way to simply strike out offending language and come up with an enforceable noncompete.
But let’s change the hypothetical a bit. Imagine that Industrial Co. is located in Providence, Rhode Island. And now imagine that Jane Doe’s noncompete instead reads: “Jane Doe agrees, for a period of six months, not to work for any business that competes with Industrial Co. in Rhode Island, Massachusetts, Vermont, New Hampshire, Maine, or New York.”
Now – depending on Ms. Doe’s job and the business interests at stake for Industrial Co. – such a clause might be enforceable in terms of duration, but unenforceable due to an overbroad geographical scope. In this scenario, however, a blue-pencil jurisdiction might reach the same result as an equitable reformation jurisdiction; the blue-pencil court could simply strike “…Massachusetts, Vermont, New Hampsire, Maine, or New York” from the clause, leaving Ms. Doe with an otherwise-valid noncompete that prevents her only from taking a competing job in Rhode Island.1
The bottom line is that if you are drafting, seeking to enforce, or seeking to contest a noncompete agreement, you need to know more than just whether they agreement is enforceable as written. You also need to know whether the court will rewrite the agreement to make it enforceable, and if so, whether that re-write is limited to just striking out offending terms (“blue-pencil”) or can extend to a substantive, affirmative change to the contract itself (“equitable reformation”).
- In our first hypothetical, we stipulated that a “20-mile radius” outside of Industrial Co.’s headquarters would be enforceable. Using simple geometry (a = πr2), the first noncompete clause covers an area of just over 1,250 square miles. The State of Rhode Island covers 1,045 square miles of land area, so a noncompete restraining Ms. Doe from all of Rhode Island is less onerous, geographically, than one that restrains her from work in a "20-mile radius," presuming that the locus is located at least 20 miles inland.